2. Cost Allocations of Service Departments
Chapter 6: Cost Allocations of Service Departments
Chapter 6

3. Cost Allocation and Charges for Services Rendered
Intracompany – inside the same entity
This chapter will cover
reasons for establishment of an internal service charging system or to have an cost allocation system
techniques and principles of allocation to be used
allocation of service department costs to operating departments using the direct and step-down methods
Cost allocation and charges for services rendered can be examined from the intracompany and intercompany perspectives.
This chapter will only focus on the intracompany aspects (i.e. inside the same entity), covering:
1. reasons for establishment of an internal service charging system or to have an cost allocation system
2. techniques and principles of allocation to be used
3. allocation of service department costs to operating departments using the direct and step-down methods

4. Cost Allocation and Charges for Services Rendered
Intercompany – different entities within the same group
Transfer pricing
may help group’s tax planning
may be monitored and scrutinized by tax authorities and other interested regulating bodies/agents.
needs to be seen as an “arm’s length transaction”
Will be covered in Chapter 13 Appendix A
The intercompany perspective on cost allocation and charges for services rendered
May involve group’s tax planning
May be monitored and scrutinized by tax authorities and other interested regulating bodies/agents
In general, the charge needs to be seen as an “arm’s length transaction”
Transfer pricing issues involving intercompany will be covered in Chapter 13 Appendix A

5. Learning Objective 1
Explain the major reasons for the need for allocating nonmanufacturing costs.
Learning objective number 1 is to explain the major reasons for the need for allocating nonmanufacturing costs.

6. Service Department Charges
Operating Departments
Service Departments
Carry out central purposes of organization.
Do not directly engage in operating activities.
Most large organizations have both operating departments and service departments. The central purposes of the organization are carried out in the operating departments. In contrast, service departments do not directly engage in operating activities. This chapter discusses why and how service department costs are allocated to operating departments.

7. Reasons for Charging Service Department Costs
Service department costs are charged to operating departments for a variety of reasons including:
To encourage operating departments to wisely use service department resources.
To provide operating departments with more complete cost data for making decisions.
Service department costs are charged to operating departments for a variety of reasons including:
1.    To encourage operating departments to wisely use service department resources.
2.    To provide operating departments with more complete cost data for making decisions.
3.    To help measure the profitability of operating departments.
4. To create an incentive for service departments to operate efficiently.
To help measure the profitability of operating departments.
To create an incentive for service departments to operate efficiently.

8. Management Needs
Need to understand the full cost of providing a product or service (including supporting costs) to make better decisions.
Ensuring competitive costing and pricing
Assessment of risk and potential success of the product/service
Financial and operational forecasts and planning
Motivating performance evaluation and reward system
Communicating to employees about the importance of recovering all indirect costs
Encouraging efficient and effective use of resources
Ensuring long-term sustainability and competitiveness
Management and employees need to understand the full cost of providing a product or service (including supporting costs) to make better decision.
Ensuring competitive costing and pricing
Assessment of risk and potential success of the product/service
Financial and operational forecasts and planning
Motivating performance evaluation and reward system
Communicating to employees about the importance of recovering all indirect costs
Encouraging efficient and effective use of resources
Ensuring long-term sustainability and competitiveness

9. Operating Departments
Transfer Prices
The service department charges considered can be viewed as a transfer price that is charged for services provided by service departments to operating departments/companies within the group.
The service department charges considered can be viewed as a transfer price that is charged for services provided by service departments to operating departments/companies within the group. $
Service Departments
Operating Departments

10. Factors to be Considered in the Cost Allocation Approach and Intercompany/Interdepartmental charges
Cost-benefit Evaluation
Including tangible and intangible costs and benefits
Cause and effect
Absorption of cost based on who causes it
Benefit Received
Absorption of cost based on the ultimate benefactor
Ability to Bear
Absorption of cost based on who/which product has the ability and profit margin to bear the cost
Fairness or Equity
Ensuring fair game and decent profit to motive service provider, for example, use of a cost-plus performance based award fee approach, to ensure quality delivery of service/product
When allocating costs to operating divisions or subsidiaries within the group, the following factors should be considered:
Cost-benefit Evaluation
Including tangible and intangible costs and benefits as most companies only consider tangible costs and benefits, ignoring intangible costs such as internal fighting and inefficiency
Cause and effect
Absorption of cost based on who causes it
Benefit Received
Absorption of cost based on the ultimate benefactor
Ability to Bear
Absorption of cost based on who/which product has the ability and profit margin to bear the cost, an important factor for group based tax planning
Fairness or Equity
Ensuring fair game and decent profit to motive service provider, for example, use of a cost-plus performance based award fee approach, to ensure quality delivery of service/product

11. Service Department Charges

12. Learning Objective 2
Allocate costs of service departments to other operating departments/units using the cost behavior concept.
Learning objective number 2 is to allocate costs of service departments to other operating departments/units using the cost behavior concept.

13. Charging Costs by Behavior
Whenever possible, variable and fixed service department costs should be charged separately.
Whenever possible, variable and fixed service department costs should be charged separately to provide more useful data for planning and control of departmental operations.

14. Charging Costs by Behavior
Variable service department costs should be charged to consuming departments according to whatever activity causes the incurrence of the cost.
Variable service department costs should be charged to consuming departments according to whatever activity causes the incurrence of the cost.

15. Charging Costs by Behavior
Charge fixed service department costs to consuming departments in predetermined lump-sum amounts that are based on the consuming department’s peak-period or long-run average servicing needs.
Fixed costs should be charged to consuming departments in predetermined lump-sum amounts that are based on the consuming department’s peak-period or long-run average servicing needs. Importantly, fixed cost allocations:
Are based on the amount of capacity each consuming department requires.
Should not vary from period to period.
Are based on amounts of capacity each consuming department requires.
Should not vary from period to period.

16. Should Actual or Budgeted Costs Be Charged?
Budgeted variable and fixed service department costs should be charged to operating departments.
Budgeted variable and fixed service department costs (rather than actual costs) should be charged to operating departments. Actual costs may contain inefficiencies that should not be charged to operating departments. Variable service department costs should be charged using a predetermined rate applied to the actual services consumed. The lump-sum amount of fixed costs should be based on budgeted fixed costs, not actual fixed costs.

17. Sipco: An Example
Sipco has a maintenance department and two operating departments: Cutting and Assembly. Variable maintenance costs are budgeted at $0.60 per machine hour. Fixed maintenance costs are budgeted at $200,000 per year. Data relating to the current year are:
Let’s look at an example of allocating costs by behavior. Sipco has one service department, Maintenance, and two operating departments: Cutting and Assembly. Variable maintenance costs are budgeted at $0.60 per machine hour. Fixed maintenance costs are budgeted at $200,000 per year.
Both planned and actual hours are given. We will allocate variable costs at the end of the year using actual hours. We will allocate fixed costs based on percent of peak capacity required.
Allocate maintenance costs to the two operating departments.

18. Sipco: End of the Year Actual hours
Variable cost allocations are made at the end of the year by multiplying the budgeted variable rate of $0.60 per machine hour by the actual hours for each operating department.

19. Percent of peak-period capacity.
Sipco: End of the Year
Actual hours
Fixed service department costs are allocated to the operating departments by multiplying the percent of peak-period capacity required by each department times the $200,000 of budgeted fixed costs.
Percent of peak-period capacity.

20. Quick Check 
Foster City has an ambulance service that is used by the two public hospitals in the city. Variable ambulance costs are budgeted at $4.20 per mile. Fixed ambulance costs are budgeted at $120,000 per year. Data relating to the current year are:
Let’s take a quick check and see how we are doing on allocating costs by behavior. Foster City has an ambulance service that is used by the two public hospitals in the city. Variable ambulance costs are budgeted at $4.20 per mile. Fixed ambulance costs are budgeted at $120,000 per year. Data relating to the current year are illustrated in the table on the slide. You may want to refer back to this screen as you work through the question on the next slide.

21. Quick Check 
How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?
a. $121,200
b. $254,400
c. $139,500
d. $117,000
How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?

22. Quick Check 
How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?
a. $121,200
b. $254,400
c. $139,500
d. $117,000
Variable cost allocations are made at the end of the year by multiplying the budgeted variable rate of $4.20 per mile by the actual number of miles for each hospital.
Fixed service department costs are allocated to the hospitals by multiplying the percent of peak-period capacity required by each hospital times the $120,000 of budgeted fixed costs.
So, the total cost allocated to Mercy Hospital at the beginning of the year is $121,200.

23. Pitfalls in Allocating Fixed Costs
Allocating fixed costs using a variable allocation base.
Result
Fixed costs allocated to one department are heavily influenced by what happens in other departments.
Rather than charge service department fixed costs to operating departments in predetermined lump-sum amounts, some companies allocate them using a variable allocation base that fluctuates from period to period. This is a pitfall because it creates a situation where the fixed costs allocated to one operating department are heavily influenced by what happens in other operating departments.

24. Pitfalls in Allocating Fixed Costs
Using sales dollars as an allocation base.
Result
Sales of one department influence the service department costs allocated to other departments.
While sales dollars is a popular allocation base for service department costs, it is a poor choice because sales dollars fluctuate from period to period, and the costs being allocated are often largely fixed. Allocation of service department costs based on sales can create a situation where the sales of one department influence the service department costs allocated to other departments.

25. Autos R Us – An Example
Autos R Us has one service department and three sales departments, New Cars, Used Cars, and Car Parts. The service department costs total $80,000 for both years in the example. Contrary to good practice, Autos R Us allocates the service department costs based on sales.
Let’s look at an example to illustrate the pitfalls of allocating service department costs based on sales revenue.
Autos R Us has one service department and three sales departments, New Cars, Used Cars, and Car Parts. The service department costs total $80,000 for both years in the example. Contrary to good practice, Autos R Us allocates the service department costs based on sales.

26. Autos R Us – First-year Allocation
$1,500,000 ÷ $3,000,000
50% of $80,000
Part I
We will focus on the New Cars department in this example. In the first year, sales for the New Cars department are $1,500,000 of the $3,000,000 of total sales ($3,000,000 x 50% = $1,500,000). We allocate the service department costs to the New Cars department by multiplying 50% times $80,000. The result is $40,000.
Part II
In the next year, the manager of the New Cars department increased sales by $500,000. Sales in the other departments are unchanged. Let’s allocate the $80,000 service department cost for the second year given the sales increase.
In the next year, the manager of the New Cars department increases sales by $500,000. Sales in the other departments are unchanged. Let’s allocate the $80,000 service department cost for the second year given the sales increase.

27. Autos R Us – Second-year Allocation
$2,000,000 ÷ $3,500,000
57% of $80,000
Part I
In the second year, the sales for the New Cars department are $2,000,000 of the $3,500,000 of total sales ($3,500,000 x 57% = $2,000,000). We allocate the service department costs to the New Cars department by multiplying 57% times $80,000. The result is $45,714.
Part II
The allocation of service department costs to the New Cars department increased by $5,714. The allocation of service department costs to the other two departments decreased. The New Cars department manager is likely to complain because her department is being forced to bear a larger share of service department costs simply because of her sales team’s efforts to increase sales.
If you were the manager of the New Cars department, would you be happy with the increased service department costs allocated to your department?

28. Service Department Allocations
4-27
Service Department Allocations
Service Department Allocations.
In this section, we will look at the allocation of service department costs to operating departments.

29. Operating Departments
4-28
Operating Departments
An operating department carries out the central purpose of the organization
The Geography Department at the University of Washington.
The Surgery Department at Mount Sinai Hospital.
A Production Department at Mitsubishi.
Operating departments carry out the central purpose of the organization. Examples of operating departments include:
The Surgery Department at Mt. Sinai Hospital.
The Geography Department at the University of Washington.
The production departments at Mitsubishi.

30. Service departments do not directly engage in operating activities.
4-29
Service Departments
Service departments do not directly engage in operating activities.
The Accounting Department at Macy’s.
The Human Resources Department at Walgreens.
Service departments do not directly engage in operating activities. They provide services or assistance to the operating departments. Other examples of service departments include:
Cafeteria.
Internal Auditing.
Human Resources.
Accounting.

31. Interdepartmental Services
4-30
Interdepartmental Services
Service Department
Operating Department
Costs of the service department become overhead costs to the operating department
The overhead costs of operating departments frequently include allocations of costs from service departments. To the extent service department costs are classified as production costs, they should be included in unit product costs and thus must be allocated to operating departments in a process costing system.

32. Allocation Approaches
4-31
Allocation Approaches
Direct Method 
Step-Down Method 
Three approaches are used to allocate service department costs to other departments—the direct method, the step-down method, and the reciprocal method.
Reciprocal Method 

33. Reciprocal Services Service Department 1 Service Department 2
4-32
Reciprocal Services
Service Department 1
Service Department 2
When service departments provide services to each other we call them reciprocal services.
Keep in mind that many service departments provide services to each other, as well as to operating departments. Services provided between service departments are known as interdepartmental or reciprocal services.

34. 4-33
Learning Objective 3
Allocate service department costs to operating departments using the direct method.
Learning objective number 3 is to allocate service department costs to operating departments using the direct method.

35. Direct Method Service Department (Cafeteria) Operating Department
4-34
Direct Method
Service Department
(Cafeteria)
Operating Department
(Machining)
Interactions between service
departments are ignored and all
costs are allocated directly to operating departments.
Service Department
(Custodial)
Operating Department
(Assembly)
The direct method is the simplest of the three cost allocation methods because it ignores the services provided by a service department to other service departments. Interactions between service departments are ignored and all costs of each service department are allocated directly to operating departments.

36. Direct Method – An Example
4-35
Direct Method – An Example
In the example shown on your screen, a company has two service departments, Cafeteria and Custodial, and two operating departments, Machining and Assembly. Cafeteria costs are allocated to the operating departments based on the number of employees in each department. Custodial costs are allocated to each operating department based on the number of square feet in each operating department.

37. Direct Method – An Example
4-36
Direct Method – An Example
How much of the Cafeteria and Custodial costs should be allocated to each operating department using the direct method of cost allocation?
How much of the Cafeteria and Custodial costs should be allocated to each operating department using the direct method of cost allocation?

38. Direct Method – An Example
4-37
Direct Method – An Example
Using the direct method of cost allocation, it doesn’t matter which service department we allocate first. We will start with cafeteria. The total number of employees in the allocation base is 50, 20 for Machining plus 30 for Assembly. Recall that we ignore the number of employees in Custodial as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Machining, the allocation percentage is 40%, obtained by dividing 20 employees by 50 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Machining we multiply 40% times $360,000 and get $144,000. Quantities of the allocation base attributed to the service departments are ignored.
$360,000 × 20
= $144,000
Allocation base: Number of employees

39. Direct Method – An Example
4-38
Direct Method – An Example
Next, let’s allocate Cafeteria costs to Assembly. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Assembly, the allocation percentage is 60%, obtained by dividing 30 employees by 50 employees. To allocate Cafeteria costs to Assembly we multiply 60% times $360,000 and get $216,000.
Note that the sum of the costs assigned to Assembly ($216,000) and Machining ($144,000) is equal to the total costs assigned from the Cafeteria ($360,000).
$360,000 × 30
= $216,000
Allocation base: Number of employees

40. Direct Method – An Example
4-39
Direct Method – An Example
Now let’s allocate Custodial costs. The total number of square feet in the allocation base is 75,000, 25,000 for Machining plus 50,000 for Assembly. Recall that we ignore the square feet in Cafeteria as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the square feet in an operating department by the total number of square feet in the allocation base. For Machining, the allocation percentage is 33-1/3%, obtained by dividing 25,000 square feet by 75,000 square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Machining we multiply 33-1/3% times $90,000 and get $30,000.
$90,000 ×
25,000
25, ,000
= $30,000
Allocation base: Square feet occupied

41. Direct Method – An Example
4-40
Direct Method – An Example
Next, let’s allocate Custodial costs to Assembly. The total number of square feet in the allocation base is 75,000, 25,000 for Machining plus 50,000 for Assembly. The allocation percentage is calculated by dividing the square feet in an operating department by the total number of square feet in the allocation base. For Assembly, the allocation percentage is 66-2/3%, obtained by dividing 50,000 square feet by 75,000 square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Assembly we multiply 66-2/3% times $ and get $60,000. The sum of the costs assigned to Assembly ($60,000) and Machining ($30,000) is equal to the total costs assigned from the Custodial Department ($90,000).
50,000
25, ,000
$90,000 ×
= $60,000
Allocation base: Square feet occupied

42. 4-41
Learning Objective 4
To allocate service department costs to operating departments using the step-down method.
Learning objective number 4 is to allocate service department costs to operating departments using the step-down method.

43. Step-Down Method Service Department (Cafeteria) Operating Department
4-42
Step-Down Method
Service Department
(Cafeteria)
Operating Department
(Machining)
Once a service department’s costs are allocated, other service department costs are not allocated back to it.
Service Department
(Custodial)
Operating Department
(Assembly)
The step-down method provides for the allocation of a service department’s costs to other service departments, as well as to operating departments. It is a sequential allocation procedure, and the sequence usually begins with the service department that provides the greatest amount of service to other service departments. Once a service department’s costs have been allocated to other departments, other service department costs are not allocated back to it.

44. 4-43
Step-Down Method
There are three key points to understand regarding the step-down method:
 In both the direct and step-down methods, any
amount of the allocation base attributable to the
service department whose cost is being allocated is
always ignored.
 Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.
 Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments.
There are three key points to understand regarding the step-down method:
 In both the direct and step-down methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.
 Any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.
 Each service department assigns its own costs to operating departments plus the costs that have been allocated to it from other service departments.

45. Step-Down Method – An Example
4-44
Step-Down Method – An Example
We will use the same data used in the direct method example.
We will use the same information shown on your screen for the step-down method example. There are two service departments, Cafeteria and Custodial, and two operating departments, Machining and Assembly. Cafeteria costs are allocated to the operating departments based on the number of employees in each department. Custodial costs are allocated to each operating department based on the number of square feet in each operating department.

46. Step-Down Method – An Example
4-45
Step-Down Method – An Example
How much of the Cafeteria and Custodial costs should be allocated to each operating department using the step-down method of cost allocation?
We will allocate Cafeteria first since it is larger and provides more service to Custodial than Custodial provides to Cafeteria.
Allocate Cafeteria costs first since it provides more service than Custodial.

47. Step-Down Method – An Example
4-46
Step-Down Method – An Example
$360,000 × 10
= $60,000
The total number of employees in the allocation base is 60, 10 for Custodial plus 20 for Machining plus 30 for Assembly. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Custodial, the allocation percentage is 16-2/3%, obtained by dividing 10 employees by 60 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Custodial, we multiply 16-2/3% times $360,000 and get $60,000.
Allocation base: Number of employees

48. Step-Down Method – An Example
4-47
Step-Down Method – An Example
$360,000 × 20
= $120,000
Next, let’s allocate Cafeteria costs to Machining. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Machining, the allocation percentage is 33-1/3%, obtained by dividing 20 employees by 60 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Machining, we multiply 33-1/3% times $360,000 and get $120,000.
Allocation base: Number of employees

49. Step-Down Method – An Example
4-48
Step-Down Method – An Example
$360,000 × 30
= $180,000
Next, let’s allocate Cafeteria costs to Assembly. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Assembly, the allocation percentage is 50%, obtained by dividing 30 employees by 60 employees. Next we multiply the allocation percentage times the service department cost. To allocate Cafeteria costs to Assembly, we multiply 50% times $360,000 and get $180,000. The sum of the assigned costs ($60,000 + $120,000 + $180,000) equals the total Cafeteria Department costs of $360,000.
Allocation base: Number of employees

50. Step-Down Method – An Example
4-49
Step-Down Method – An Example
New total = $90,000 original Custodial cost plus $60,000 allocated from the Cafeteria.
Now, we can allocate Custodial costs. The costs in Custodial are now $150,000. This amount includes the department’s own costs of $90,000 plus the $60,000 allocated from Cafeteria. None of the $150,000 will be allocated back to Cafeteria. How much of the Custodial costs should be allocated to each operating department using the step-down method of cost allocation?

51. Step-Down Method – An Example
4-50
Step-Down Method – An Example
$150,000 ×
25,000
25, ,000
= $50,000
The total number of square feet in the allocation base is 75,000, 25,000 for Machining plus 50,000 for Assembly. The allocation percentage is calculated by dividing the square feet in a department by the total number of square feet in the allocation base. For Machining, the allocation percentage is 33-1/3%, obtained by dividing 25,000 square feet by 75,000 square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Machining we multiply 33-1/3% times $150,000 and get $50,000.
Allocation base: Square feet occupied

52. Step-Down Method – An Example
4-51
Step-Down Method – An Example
$150,000 ×
50,000
25, ,000
= $100,000
Next, let’s allocate Custodial costs to Assembly. The total number of square feet in the allocation base is 75,000, 25,000 for Machining plus 50,000 for Assembly. The allocation percentage is calculated by dividing the square feet in an operating department by the total number of square feet in the allocation base. For Assembly, the allocation percentage is 66-2/3%, obtained by dividing 50,000 square feet by 75,000 square feet. Next we multiply the allocation percentage times the service department cost. To allocate Custodial costs to Assembly we multiply 66-2/3% times $150,000 and get $100,000. The sum of the costs assigned to Assembly ($100,000) and Machining ($50,000) is equal to the total costs assigned from the Custodial Department ($150,000).
Allocation base: Square feet occupied

53. 4-52
Reciprocal Method
Service Department
(Cafeteria)
Operating Department
(Machining)
Interdepartmental services are given full recognition rather than partial recognition as with the step method.
Service Department
(Custodial)
Operating Department
(Assembly)
The reciprocal method gives full recognition to interdepartmental services. While the step method only allocates forward – never backwards – the reciprocal method allocates service department costs in both directions. Reciprocal allocation requires the use of simultaneous linear equations and is beyond the scope of our discussion.
The reciprocal method is rarely used in practice because of its complexity and because the results are usually close to the step-down method results.
Because of its mathematical complexity, the reciprocal method is rarely used.

54. Quick Check Data for Direct and Step-Down Methods
4-53
Quick Check Data for Direct and Step-Down Methods
The direct method of allocation is used.
Allocation bases:
Business school administration costs (ADMIN): Number of employees
Business Administration computer services (BACS): Number of personal computers
On your screen, you see information for a series of questions. The first cost allocation questions use the direct method. You will probably want to refer back to this screen as you work through the questions.

55. 4-54
Quick Check 
How much cost will be allocated from Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000
Here’s your first question using the direct method of service department cost allocation.

56. 4-55
Quick Check 
How much cost will be allocated from Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000
The total number of employees in the allocation base is one hundred, twenty in Accounting plus eighty others. Recall that we ignore the number of employees in BACS as it is a service department and using the direct method, we only allocate to operating departments. The allocation percentage is calculated by dividing the number of employees in an operating department by the total number of employees in the allocation base. For Accounting, the allocation percentage is 20%, obtained by dividing 20 employees by 100 employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to Accounting we multiply 20% times $180,000 and get $36,000.
$180,000 × 20
= $36,000

57. 4-56
Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500
Here’s your second question using the direct method of service department cost allocation.

58. 4-57
Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500
$90,000 × 18
= $13,500
We will allocate BACS costs to Accounting and add the result to the answer for the previous question. BACS is allocated on the basis of the number of personal computers in each operating department. The total number of personal computers in the allocation base is 120, 18 for Accounting plus 102 others. The allocation percentage is calculated by dividing the number of personal computers in an operating department by the total number of personal computers in the allocation base. For Accounting, the allocation percentage is 15%, obtained by dividing 18 personal computers by 120 personal computers. To allocate BACS costs to Accounting, we multiply 15% times $90,000 and get $13,500. The total amount allocated to Accounting is the sum of $36,000 and $13,500 for a total of $49,500.

59. The step method of allocation is used.
4-58
Quick Check Data
The step method of allocation is used.
Allocation bases:
Business school administration costs (ADMIN): Number of employees
Business administration computer services (BACS): Number of personal computers
Now we will look at a question where we will use the step-down method of service department cost allocation. The information on your screen for this question is the same information that we used for the direct method questions.

60. 4-59
Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333
Here’s your question using the step-down method of service department cost allocation.

61. 4-60
Quick Check 
How much total cost will be allocated from ADMIN and BACS combined to the Accounting Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333
ADMIN provides more service than BACS so we allocate it first. The total number of employees in the allocation base is 105, 5 for BACS, plus 20 for Accounting, plus 80 others. The allocation percentage is calculated by dividing the number of employees in a department by the total number of employees in the allocation base. For Accounting, the allocation percentage is found by dividing 20 employees by 105 employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to Accounting we multiply the allocation percentage times $180,000 and get $34,286.
We must also allocate ADMIN costs to BACS. The allocation percentage is found by dividing 5 employees by 105 employees. Next we multiply the allocation percentage times the service department cost. To allocate ADMIN costs to BACS, we multiply the allocation percentage times $180,000 and get $8,571.
The new amount to be allocated from BACS is the original $90,000 plus $8,571, for a total of $98,571.
Now we can allocate BACS costs to Accounting. For BACS, the allocation percentage of 15% is found by dividing 18 computers by 120 computers. Next we multiply the allocation percentage times the service department cost. To allocate BACS costs to Accounting, we multiply 15% times $98,571 and get $14,786.
The total amount allocated to Accounting is $49,072.

62. End of Chapter 6
End of chapter 6.